presentation 31 05 11 (acca)
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Measuring value creation: Requirements of an effective management
reporting system
Banking Club’s breakfast
Alexei Blagirev31.05.12Moscow
How Banks create value: Measures..
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1. Focus on ROE encourage the bankers to choose a strategy of high leverage and risky investments to drive performance and fuels banks to new regulations require to have new equity. They are good for economy but not prevent future losses.
*Source: “Rethinking how banks create value’, June 2011, ICAEW Journal ,Anat Admati,
2. ROE doesn’t tell anything about value creation for shareholders, more over, it may rise because of increase of leverage which brings further higher risks.
3.Comparison of ROE across Banks is meaningless, because the manager who produces value for shareholder could have a lower ROE than others.*
Professionals are not seeking the luck on the market and should use adequate measurements to protect their investments
- How to adhere management compensation (LTI, etc) to performance and encourage the bankers to drive value of the business (TSR or RTSR, CAGR)?
- How to concentrate performance on appropriate measures (EVA)?
Q:
Where the value could be lost in the Banks?
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*Source: beyondBanking: banking on global sustainability, IDB 2012
Value structure for society* ?Value structure for investor?
-Sustainable performance-Strong strategy and adherence to proven corporate values- Adherence to operational excellence-Strong internal control and risk management systems- Strong knowledge management systems
Proposed basement for Reporting is Value Measuring Methodology (VMM)** which guides to define three components:1. Value structure (Customer, Social, Strategic, Operational, Financial), see examples above
2. Cost structure3. Risk structure
**Developed initially by Booz&Allen in 2002 in report to US Social Security Administration, as part of an electronic services project
Executive Summary (principles)
“one should have full knowledge of one's own strengths and weaknesses as well as those of one's enemies. Lack of either set of knowledge might result in defeat”, Art of War, Sun Tzu
BI foundation
Planning
Controlling
Modeling
Collecting and consolidation
Original CPM techniques:Economic value added Balanced scorecard Activity-based costing Total Quality Management Theory of Constraints
Strategy + enterprise risk management and day-to-day decision making
“Risk appetite is the amount of risk, on a broad level,an organization is willing to accept in pursuit of value.Each organization pursues various objectives to addvalue and should broadly understand the risk it iswilling to undertake in doing so.”*
* Source: Understanding and Communicating Risk Appetite, COSO 2012. There is no right/standard/universal report.4
Conception of sustainable banking (SEMS**)
Effective Management Reporting System
**Source: Banking on Sustainability, IFC 2007 report
Report Example (Profit and Loss)
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*appropriateness such techniques for S&M banks is a point for discussion. In most such banks don’t have any ERM at all.Sometimes they also referred as “live or die” ratios
FACT:Financial metrics are ONLY subordinate translational result (secondary)Initial are drivers !
**EVA Initially Expressed in 1989 by Stern Stewart & Co.
Other value drivers:1. Social footprint (Anthro capital performance)2. Cost of critical processes
Business Drivers (Banking)*:
1. Sales volume (sales effectiveness)2. Pricing (Competition in dynamic environment)3. Costs (finance costs, opex and processes)4. Risks (credit risk tolerance)
Key Risk Indicators (examples):1. Process efficiency2. Sales effectiveness3. External factors (funding)4. Competition pressure (pricing and product
development
Contingency and cost engineering principles(risk and performance)
AACE (USA) described 4 approaches applied in industry for contingency estimates**:- Expert judgment- Predetermined guidelines- Monte Carlo or other simulation- Parametric Modelling
Linking risk management to performance management is a new business imperative.
Only 37 % of senior executives surveyed by PwC across industries said that theircompanies linked key risk indicators with key performance indicators.*
*Source: 2008 PwC, Q2 Management Barometer; American Recovery and Reinvestment Act of 2009
Risk
Manager
Operational
Manager
Integrated Performance
Metrics
**Source: 2007 AACE, Monte Carlo Challenge
The information is not the problem (keep in mind BI Foundation), the problem is to decide what is important (See Appendix #1)
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Appendix 1: map probability of change across KRI
“Each business unit might map the probability of change, in a given magnitude, across key risk indicators for customer satisfaction, process efficiency, and competition, against the potentialimpacts on earnings volatility (see Figure).
Such an integrated view can help management decide how resources—such as capital and talent—should be allocated to minimize volatility while achieving the organization’s objectives.
Perhaps most important, aligning risk and performance information in such a way can help business unit leaders forge a common view of the division’s risk tolerance and appetite, which is critical to the company’s ability to manage its risk portfolio and overall business performance.”*
7*Source: PwC Linking Risk and Performance, 2009
Appendix 2: Map of sources of risk and performance
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*Source: PwC Linking Risk and Performance, 2009
Appendix 3: Risk performance cycle
9*Source: PwC Linking Risk and Performance, 2009
Referred to as economic capital in the financial services sector, this is a key metric for decision making around any potentially risky business initiative
Only 9 % of respondents believed their board of directors was very knowledgeable about economic capital, while 22 percent considered their board not knowledgeable at all.
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Appendix 4: KPI, Risk appetite and risk tolerance
Source: 2010, BOOZ&Co, Comprehensive Risk Appetite Framework by Paul Hyde, Thorsten Liebert, Philipp Wackerberk
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